Goods news, if you’re employed full time in Australia, you are already an investor. Each pay your employer automatically sends 9.5% (this will increase) of your salary to your superannuation fund of choice. As you’re here, I’m sure you already understand what super is and why it’s important. You’re here because you know the importance of investing. Still, you’re not sure where to begin, and you either don’t have time for an online course or you don’t know which would be the best use of your money, and you’re afraid if you wing-it you may lose everything.
There’s no need to fear, this guide will walk you through all the basics. It’s shorter than an online course, and it’s also completely free. I’ll guide you through how to optimize for returns and limit time consumed while also steering you away from people who would do the work for you but takes half the gains.
What is investing?
Investing is the process of giving up your money now in return for what you expect to be more money in future. It can take money forms from investing in shares which is acquiring ownership of a company. It could be investing in bonds, which provides a company with the money it needs now in exchange for set payments at future dates. It could even be investing in property or lending
Why Should You Invest?
There’s one reason most people invest and that’s to grow their money. I want you to do one better, the reason that you should invest is to grow your ‘real’ money. Real refers to what your money is worth rather than the amount of it that you have. Real money considers the cost of living, also known as inflation. If you would like to learn more about inflation, you can do so HERE, but for the sake of this article all you need to know is that inflation is the rate at which the cost of living increases. If you invest $100 in a savings account which provides a guaranteed return of 2% you will have $102 after 12 months. Doesn’t seem terrible for doing nothing, does it? The problem is that if everything now costs 3% more than it did a year ago you really have less money than you started with. For this reason, your goal in investing should generally be to not only grow your money but to also protect against inflation.
So, what’s the benefit of growing your real money? We’ve all heard the saying ‘money can’t buy happiness’, and while that’s somewhat true, money does provide options. If you lose your job, you can take your time to figure things out. If you’re having a baby, you can take time off work or even leave your job. If you hate your current situation money allows you to pack your bags and go anywhere in the world. Money may not buy happiness, but it can significantly reduce stress and enable you to live the life you want to live. If you ever wondered, why should I invest? Think about any time you were caused stress because you didn’t know what something would cost, or you didn’t think you could afford what you needed. Or even better, think about what you want to do in the future. Do you want to holiday in Europe? Do you want to buy a house closer to the city? Do you want to retire early? No matter what your goal is, there’s a good chance that money will help you get there and investing is what will get you the money you need.
What Should I Invest In?
At this point, you’re either scared worrying about upcoming bills or excited about the things you could do with money. Regardless, your next question is most likely, what should I invest in? The answer to this will likely depend on which camp you are in. If you have limited savings and the idea of an unexpected bill scares you, then your first priority should be an emergency account. Once you have that emergency account up to a level that you feel happy with it’s a great achievement and a wonderful feeling, congratulations and now it’s time to start investing.
Rule 1: Never Investment More Than You Can Afford to Lose
Investing is an excellent decision in the long run but short term it can go both up and down. If you only have $5,000 and you may need that in an emergency, you’re best to place that money in an emergency fund. It’s exciting to think of what it can become if it’s invested, but if you’re forced to sell in the short-term, you may lose money at the time you need it the most.
Rule 2: Understand What Level of Risk You Are Comfortable with
Australian stocks have returned about 13% on average over the past 120 years, but if you’re going to pull all of your money out the first time they decline 10% then stocks are not for you. On average they fall 10% about once a year, and if you take your money out when this happens, you will miss the upside that almost always follows. If you can’t handle watching the value of your investments decrease by 20-30% in the short-term, then you’re best to invest in a less risky option like bonds or term deposits. Or potentially just have a smaller proportion of stocks in your portfolio. At the end of the day it’s all personal preference but be aware of the level of risk that you are willing to accept and structure your investments accordingly.
Choosing what to invest in will depend on the how much you have to invest, the level of risk you are willing to take (your risk appetite) and how long you plan to invest (your investment time horizon). As you’re reading an article on how to start investing, you’re likely between the ages of 20 and 60, with another 20+ years of working and investing ahead of you. This allows you to focus on higher risk, higher return assets like stocks.
While stocks can go up and down in the short-term, we know that over the past 120 years they have returned about 13% on average and we can assume they will return something similar going forward. By investing for 20+ years, you can remove the short-term risk from investing and should, therefore, be looking for an investment that offers the best long-term returns.
What Stocks Should I buy?
You’re fully prepared for the short-term swings, and you know that stocks are the best way to grow your wealth long term. You’re probably wondering, what stocks should I buy? Why not buy them all? We live in an age where index fund investing has become incredibly easy. If you’re not fully aware of what index funds are, they more or less track the performance of a given index. An index fund is essentially a portfolio of all stocks, and you can buy it to achieve the market return, which we know is on average about 13%.
Why Invest in Index Funds Over Individual Stocks?
Index funds are great. They come in all shapes and sized and follow all sorts of markets. Vanguard offers funds that track bond markets (VAF), Australian shares (VAS), international shares (VGS) and many others. An index fund brings three significant advantages:
If your biggest concern regarding investing in the stock market is picking which stock to buy, indexing is the answer. Indexing allows you to remove the risk of individual stocks by purchasing all of them. We know the market always goes up in the long run, but not all stocks do, this puts a lot of pressure on you to pick the right stocks. I’m sure this isn’t the first you’ve heard about stocks, and maybe you fancy yourself a stock picker but consider this, investing is a zero-sum game. For every trade you win, somebody else loses, and most of the people who you are trading with have been doing this their entire lives. Many of them went to very-expensive schools and make millions of dollars a year because they know more about the financial markets than anybody else. Now tell me, do you still feel like you can pick the stock that they don’t want but is going to out-perform the market? Maybe you do or maybe you don’t, but why bother wasting your life researching and stressing over every swing when you can buy the market and generate 10% over the long-run without ever looking at your account?
We’ve already discussed the importance of diversification but buying a lot of different stocks can be expensive. If you trade with a major bank like CBA or NAB, you’re likely paying $20 a trade and even if you use one of the smaller options like Saxo (who I currently use) it’s still $7 so buying the top 300 stocks on the ASX would cost you $2,100 and then another $2,100 if you ever decided to sell. Vanguard offers an index fund that tracks the ASX 300 which you can purchase at a brokerage cost ($7 with Saxo) and within the fund Vanguard will also take a 0.1% management fee. I’m not sure about you, but $7 and 0.1% sounds a lot better than $2,100 to me.
The performance of an index fund will pretty much be equal to that of the index it tracks less the fees charged by the fund. If you’re buying VAS, your returns will be VAS minus the 0.1% management fee. Now you might be saying, that’s great and all but I want more than average returns. To this I would say, maybe ‘average’ isn’t the average. A recent study found that over 15 years, more than 90% of professional investors failed to beat the market return. That’s about 92% of the smartest and most experienced people in finance failing to beat what VAS can give you for $7 and a 0.1% management fee. Still feel like it’s worth picking stocks?
If I’ve piqued your interest, you can find more information on what types of Index funds are available and how to invest in them HERE.
Is Investing Isn’t Gambling?
Having read to this point, you already know that investments can decrease in value in the short-term and with greater expected returns generally comes higher risk and volatility. This can result in situations where people lose money and often creates the misunderstanding that investing is gambling.
In some ways, you could argue that investing is gambling. When you invest, there is the possibility that you might lose money in the short-term. The critical difference between gambling and investing is, you have the edge. When you play blackjack, the casino has the advantage, you may win one hand, you may even win a lot, but the casino wins eventually. When you invest in the stock market, it may go up, it may go down, but in the long run, it has always gone up.
The reason some people have bad experiences investing is largely that they do it incorrectly. To reduce the risk of losing money, you can do two things. Firstly, you want to diversify. You don’t want to own one stock no matter how good the tip you got is. There’s a very high chance that any reason your friend or colleague has given as to why this is the next big thing has already been factored into its price. The second thing that you need to remember is that the longer you invest the more likely you are to achieve your expected return. To simplify that last statement, if we assume that the stock market appreciates at 10% on average and you invest for one year you may see a return of anywhere from -30% all the way up to +50%. If you were to leave that money untouched for 30 years, there’s an excellent chance you will see a return of about 10%.
How Do I Start Investing?
At this stage, you’re likely either hell-bent on picking your own stocks or you’ve conceded that indexing may be the best way to go for 90% of people. Either way you can invest with the help of a broker. We have many options in Australia ranging from the major banks. Commonwealth Bank has their Commsec site and app or NAB has NAB Trade. We also have smaller institutions like Saxo Bank, who I personally use. They offer more modest trading fees, and I’m also a fan of their user interface. If you’re not looking for even less effort and you don’t mind paying a little extra for somebody else to do it there’s now a large number of robo advisors rising up in Australia and I think we’ll continue to see their fees decline in coming years. Some of the better-known options include Stockspot and Six Park.
Rules to Live By
There’s a near unlimited number of things to know when it comes to investing, and it’s just not possible to go through them all here, so below are some of the key pillars that you should always consider when investing.
Fees are the enemy of any investor. Where possible, ensure that you are paying as little as possible for the service or product that you are looking to buy. Even seeming small fees like 1% can add up over a long time and over 40 years could cost you as much as $500,000.
Think and Invest Long-Term
Short-term pricing can move up or down, it’s a mystery every day, so don’t try to guess which way it will be today. Park your money for the long run and benefit.
Set and Forget
It’s natural to check your account frequently when you’re just getting started, many people who have been investing for 20 years still check their account frequently but try to limit it as much as possible. You’ll likely only cause yourself stress or do something silly.
Start Early and Contribute Regularly
Compounding is your friend, the earlier you start and more money you invest the more money you will end up with. To get an idea on the significant differences that time and regular investments can make have a read through our on compound interest.
I’ve said it a million times in this article alone. Don’t risk it on one stock, just buy them all and prosper. You can also diversify further with index funds that track the markets of other financial assets.
Do Your Own Research
Thank you so much for reading, I really appreciate it. I hope that you’ve learned something new or feel a little more comfortable with the idea of investing, but it’s still important to do your own research.